Russia faces infrastructure Catch-22

A general view shows Moscow's Arbat street in this August 28, 2007 file picture.

MOSCOW, Sept 5 (Russia) - Russia's crumbling infrastructure has the government stuck in a Catch-22: it must either spend its oil reserves and drive inflation even higher, or it can continue doing nothing and watch its economy stall, experts say.

The problem has become a daily one for Russians, who feel it in the perpetual traffic jams, the two weeks without hot water every summer, and the drive from Moscow to St. Petersburg, the two biggest cities, which have no freeway link between them.

Top executives and policy makers will examine the country's dilemma in a series of exclusive interviews at the second Reuters Russia Investment Summit to be held September 8-10.

"We have not invested in infrastructure since the fall of the Soviet Union, and we are at the point now where, without it, the economy can no longer grow," said Igor Gorchakov of law firm Baker & McKenzie in St. Petersburg.

This holds true for the oil fields, power grids, ports and other nuts and bolts of the economy, and it can explain at least some of the deadly gas explosions and mine accidents that have been plaguing Russia in recent years.

"The need to renew infrastructure remains enormous and it hasn't changed," said Richard Wallis of the European Bank of Reconstruction of Development, which makes 40 percent of its Russia investments into infrastructure.

Last year, then-President Vladimir Putin estimated the cost of a top-down renewal at $1 trillion over the next 10 years, most of which was expected to come from private investors.

But getting private capital for these projects has recently become much more difficult, said one investor who helps manage more than $200 million in commitments to Russian infrastructure.

"It was already hard to get a loan amid the liquidity crisis, then it got harder because of (Russia's) political risks... So everybody is looking with increased appetites at the pockets of the state budget and reserves," the investor said.

However, with inflation nearing 15 percent on an annualized basis this year, the government is loathe to push it even higher by spending its oil windfalls, now worth more than $160 billion.

The man at the helm of the economy, Finance Minister Alexei Kudrin, is a fiscal hawk who has made inflation control a clear priority.

"If you pour money into the infrastructure sector - you line up with more inflation first and foremost and only secondarily with more activity," said Ron Smith, head of research at Alfa Bank. "But the government has no choice... Without opening up the infrastructure the economy can't grow".

LEGISLATIVE SNAGS

The Macquarie Renaissance fund, an Australian-Russian venture, has been one of the pioneering investors in this field, with plans to put $1.5 billion into airports, toll roads and similar projects across the former Soviet Union.

Because these investments have a time horizon of up to 50 or even 100 years, they are relatively immune to sudden shocks in the financial market, such as the one last month caused by Russia's brief war with Georgia.

The head of the fund, Bob Foresman of Renaissance Capital, said that once this field gets rolling, Russia is set to become the most attractive infrastructure story in the world, despite the recent blow to investor sentiment.

"We continue to see strong interest from investors looking for long-term exposure," said Andrew Hunter, head of the Europe arm of Macquarie Group (MQG.AX), which manages about $225 billion in infrastructure and real estate assets globally.

Independent experts said that these projects were in demand, with each tender getting a number of bids from foreign and local investors. But the trouble, they said, could come from how the projects are parceled out.

The most common mechanism so far has been through public-private partnerships (PPP), in which the government puts up part of the money, and then accepts bids from investors who will pay the rest and do the work.

"PPP is the most difficult sector of all," said the western banker who helps manages more than $200 million in infrastructure ventures.

"The legislation is a mess. It's not clear what procurement rules are used, and questions come up about who is making money out of the deal, and whether the tender is really transparent."

Some cities, such as St. Petersburg, have passed their own legislation to regulate PPPs. The federal laws on such contracts have been in the parliament for more than a year.

"Putin's goal of ten years is the absolute limit. If there are delays much beyond that, we will see huge problems. Not just traffic jams, but a total transport collapse," Gorchakov said.

(Editing by Erica Billingham)